Procurement of Capital Goods – Crucial Costs of Product Life Cycles

Purchasing departments are facing special challenges in the procurement of capital goods: They must handle negotiations with suppliers, keep an eye on the life cycle costs of capital goods, and generally act as interface managers. "To keep costs under control, the purchasing department must be involved, from the start, in the planning and implementation phase of the investment. Unfortunately, this is frequently not the case although large amounts of money are often concerned", says Jens Hornstein, consultant at the purchasing consultancy Kerkhoff.

Take wind energy systems, for example: "Investments for an offshore transformer station may easily run up to EUR 100 million – depending on the electrical engineering, the structural steel design and the mode of installation and setup", explains Rüdiger Voß, Head of Purchasing of BARD Engineering GmbH, in a talk with Einkäufer im Markt. The company builds wind parks on the German North Sea coast.

According to Voß, the purchase price alone is only one part of the total cost. Calculations would additionally have to include costs for the system's installation, logistics costs – especially when purchasing in low-cost countries outside of Europe; also, capital costs, depreciations, insurances, costs for maintenance and repair, as well as costs of commissioning. "It is very important for purchasing to define the scope of supply; i.e. to know what all is needed for the investment. That must be absolutely clarified prior to the award; if not, there will be the risk of expensive subsequent claims", warns the head of purchasing.

Contract must be carefully designed

According to him, great care and diligence will be required for the contract design. "Everything must be regulated in detail. We are here talking about complex investment projects, so you can't just simply say we'll complain about faulty delivery and demand our money back." The performance specifications must already be clearly defined with specifications of requirements so that there will be no misunderstandings with suppliers.

Voß uses the example of a notification of defects to explain the pitfalls of a sloppily prepared contract: "Let's assume, a period of two days is agreed upon during which defects can be notified. However, it may take more than two days in a wind park until an employee has discovered a defect and reported it and until the supplier is notified thereof. For that reason, we always stipulate periods of not under 14 days."

Since capital goods are often technically complex achievements, engineers will generally be in charge in the projects. That will rather frequently bring about that products and services to be procured are over-specified. And that means: From a commercial perspective, the solution prepared by the developers is needlessly expensive.

"Engineering is always looking for the highest-quality technical solution, but that needn't be the solution with the best price/performance ratio", states the consultant Jens Hornstein. Accordingly, purchasing would have to take care that the specification will not unnecessarily restrict the group of potential suppliers.

According to Hornstein, it is more likely that purchasing can successfully assert its interests, the more it understands about the technical aspects.

Regulate responsibilities clearly during negotiations

At BARD, negotiations with suppliers are mostly headed by a strategic buyer, says Head of Purchasing Voß. At the negotiations table, there would generally also be – in addition to a technical person – a representative of the finance department, as well as a lawyer. It would be very important to clearly assign the functions in the team prior to the beginning of the negotiations: "The technical person must be responsible for technical details, and the buyer for commercial aspects. This will prevent engineering from forming an alliance with the supplier and stabbing purchasing in the back."

Purchasing must be able to present economic alternatives

Sometimes, the opposite side would even submit a commercially reasonable proposal which would then be talked to pieces by the company's own engineering department. It would be part of the duties of the purchasing people to prevent that from happening. "Engineering often tends to "golden plate rim" solutions. Purchasing should then be able to present alternatives which are more economical", sums up the head of purchasing of BARD Engineering.

A similar thing happens with the tendency by engineering to prefer certain manufacturers. Here again, purchasing would have to assert economic aspects, explains Voß: "For example, if I ask about the credit standing of the supplier presented by engineering and whether a guaranty could be presented, then developers will see the matter in a different light already."

Mark Krieger